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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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|x | QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------



FOR THE TRANSITION PERIOD FROM             TO



Commission File Number 0-23223



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CURAGEN CORPORATION

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 06-1331400                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



|                                                         |  |           
|-------------------------------------------------------- |  | ----------
|555 Long Wharf Drive, 11th Floor, New Haven, Connecticut |  | 06511     
|(Address of principal executive office)                  |  | (Zip Code)



Registrants
telephone number, including area code: (203) 401-3330



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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90
days.    Yes  x    No ̈



Indicate by check mark whether the registrant is an
accelerated filer (as defined in Rule 12b-2 of the Exchange Act)    Yes  x    No ̈



The number of shares outstanding of the Registrants common stock as of May 1, 2004 was 50,006,130.



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##### Table of Contents

CURAGEN CORPORATION AND SUBSIDIARY

FORM 10-Q

INDEX



|                              |  |                                                                                                                 |  |       
|----------------------------- |  | --------------------------------------------------------------------------------------------------------------- |  | ------
|                              |  |                                                                                                                 |  | Page  
|PART I. Financial Information |  |                                                                                                                
|                              |  |                                                                                                                
|Item 1.                       |  | Financial Statements                                                                                            |  |       
|                              |  |                                                                                                                
|                              |  | Condensed Consolidated Balance Sheets, March 31, 2004 (unaudited) and December 31, 2003                         |  | 3     
|                              |  |                                                                                                                
|                              |  | Condensed Consolidated Statements of Operations, for the Three Months Ended March 31, 2004 and 2003 (unaudited) |  | 4     
|                              |  |                                                                                                                
|                              |  | Condensed Consolidated Statements of Cash Flows, for the Three Months Ended March 31, 2004 and 2003 (unaudited) |  | 5     
|                              |  |                                                                                                                
|                              |  | Notes to Condensed Consolidated Financial Statements (unaudited)                                                |  | 6 - 8 
|                              |  |                                                                                                                
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                           |  | 9  28
|                              |  |                                                                                                                
|Item 4.                       |  | Controls and Procedures                                                                                         |  | 28    
|                              | 
|PART II. Other Information    |  |                                                                                                                
|                              |  |                                                                                                                
|Item 2.                       |  | Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities                                |  | 29    
|                              |  |                                                                                                                
|Item 6.                       |  | Exhibits and Reports on Form 8-K                                                                                |  | 29    
|                              | 
|Signatures                    |  | 31                                                                                                             
|                              | 
|Exhibit Index                 |  | 32                                                                                                             



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##### Table of Contents

CURAGEN CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value and share data)



|                                                                                                                                     |  |               |          |   |                  |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------ |  | ------------- | -------- | - | ---------------- | - | -------- | -
|                                                                                                                                     |  | March 31,2004 |          |   | December 31,2003 |  
|                                                                                                                                     |  | (unaudited)   |          |   |                  |  
|ASSETS                                                                                                                               |  |               |          |   |                  |   |          |  
|Current assets:                                                                                                                      |  |               |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                                            |  | $             | 153,328  |   |                  | $ | 42,843   |  
|Short-term investments                                                                                                               |  |               | 30,196   |   |                  |   | 72,402   |  
|Marketable securities                                                                                                                |  |               | 224,070  |   |                  |   | 228,396  |  
|                                                                                                                                     |  |               |          |   |                  |   |          |  
|Cash and investments                                                                                                                 |  |               | 407,594  |   |                  |   | 343,641  |  
|Income taxes receivable                                                                                                              |  |               | 523      |   |                  |   | 429      |  
|Other current assets                                                                                                                 |  |               | 38       |   |                  |   | 26       |  
|Prepaid expenses                                                                                                                     |  |               | 2,371    |   |                  |   | 1,757    |  
|                                                                                                                                     |  |               |          |   |                  |   |          |  
|Total current assets                                                                                                                 |  |               | 410,526  |   |                  |   | 345,853  |  
|                                                                                                                                     |  |              
|Property and equipment, net                                                                                                          |  |               | 22,661   |   |                  |   | 23,540   |  
|Intangible and other assets, net                                                                                                     |  |               | 10,489   |   |                  |   | 7,564    |  
|                                                                                                                                     |  |               |          |   |                  |   |          |  
|Total assets                                                                                                                         |  | $             | 443,676  |   |                  | $ | 376,957  |  
|                                                                                                                                     |  |               |          |   |                  |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                 |  |               |          |   |                  |   |          |  
|Current liabilities:                                                                                                                 |  |               |          |   |                  |   |          |  
|Accounts payable                                                                                                                     |  | $             | 2,573    |   |                  | $ | 4,661    |  
|Accrued expenses                                                                                                                     |  |               | 3,863    |   |                  |   | 3,671    |  
|Accrued payroll and related items                                                                                                    |  |               | 1,435    |   |                  |   | 1,864    |  
|Interest payable                                                                                                                     |  |               | 1,849    |   |                  |   | 3,750    |  
|Deferred revenue                                                                                                                     |  |               | 2,472    |   |                  |   | 3,010    |  
|Current portion of obligations under capital leases                                                                                  |  |               | 57       |   |                  |   | 204      |  
|Other current liabilities                                                                                                            |  |               | 2,132    |   |                  |   | 2,383    |  
|                                                                                                                                     |  |               |          |   |                  |   |          |  
|Total current liabilities                                                                                                            |  |               | 14,381   |   |                  |   | 19,543   |  
|                                                                                                                                     |  |               |          |   |                  |   |          |  
|                                                                                                                                     |  |              
|Long-term liabilities:                                                                                                               |  |               |          |   |                  |   |          |  
|Convertible subordinated debt                                                                                                        |  |               | 240,000  |   |                  |   | 150,000  |  
|Accrued long-term liabilities                                                                                                        |  |               | 1,500    |   |                  |   | 1,500    |  
|                                                                                                                                     |  |               |          |   |                  |   |          |  
|Total long-term liabilities                                                                                                          |  |               | 241,500  |   |                  |   | 151,500  |  
|                                                                                                                                     |  |               |          |   |                  |   |          |  
|                                                                                                                                     |  |              
|Commitments and contingencies                                                                                                        |  |               |          |   |                  |   |          |  
|                                                                                                                                     |  |              
|Minority interest in subsidiary                                                                                                      |  |               | 6,848    |   |                  |   | 8,233    |  
|                                                                                                                                     |  |               |          |   |                  |   |          |  
|                                                                                                                                     |  |              
|Stockholders equity:                                                                                                                |  |               |          |   |                  |   |          |  
|Common Stock; $.01 par value, issued and outstanding 49,996,355 shares at March 31, 2004, and 49,896,622 shares at December 31,
2003 |  |               | 500      |   |                  |   | 499      |  
|Additional paid-in capital                                                                                                           |  |               | 486,011  |   |                  |   | 485,531  |  
|Accumulated other comprehensive income                                                                                               |  |               | 2,251    |   |                  |   | 1,524    |  
|Accumulated deficit                                                                                                                  |  |               | (307,531 | ) |                  |   | (289,492 | )
|Unamortized stock-based compensation                                                                                                 |  |               | (284     | ) |                  |   | (381     | )
|                                                                                                                                     |  |               |          |   |                  |   |          |  
|Total stockholders equity                                                                                                           |  |               | 180,947  |   |                  |   | 197,681  |  
|                                                                                                                                     |  |               |          |   |                  |   |          |  
|Total liabilities and stockholders equity                                                                                           |  | $             | 443,676  |   |                  | $ | 376,957  |  
|                                                                                                                                     |  |               |          |   |                  |   |          |  



See accompanying notes
to condensed consolidated financial statements



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CURAGEN CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)



|                                                                                         |  |                             |         |   |      |   |         |  
|---------------------------------------------------------------------------------------- |  | --------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                         |  | Three Months EndedMarch 31, |        
|                                                                                         |  | 2004                        |         |   | 2003 |  
|Revenue:                                                                                 |  |                             |         |   |      |   |         |  
|Collaboration revenue                                                                    |  | $                           | 1,615   |   |      | $ | 1,944   |  
|                                                                                         |  |                             |         |   |      |   |         |  
|Total revenue                                                                            |  |                             | 1,615   |   |      |   | 1,944   |  
|                                                                                         |  |                             |         |   |      |   |         |  
|Operating expenses:                                                                      |  |                             |         |   |      |   |         |  
|Research and development                                                                 |  |                             | 15,141  |   |      |   | 14,460  |  
|General and administrative                                                               |  |                             | 4,857   |   |      |   | 4,950   |  
|                                                                                         |  |                             |         |   |      |   |         |  
|Total operating expenses                                                                 |  |                             | 19,998  |   |      |   | 19,410  |  
|                                                                                         |  |                             |         |   |      |   |         |  
|                                                                                         |  |                            
|Loss from operations                                                                     |  |                             | (18,383 | ) |      |   | (17,466 | )
|Interest income                                                                          |  |                             | 2,036   |   |      |   | 2,333   |  
|Interest expense                                                                         |  |                             | (2,877  | ) |      |   | (2,475  | )
|Loss on extinguishment of debt                                                           |  |                             | (294    | ) |      |   |        |  
|                                                                                         |  |                             |         |   |      |   |         |  
|                                                                                         |  |                            
|Loss before income taxes and minority interest in subsidiary loss                        |  |                             | (19,518 | ) |      |   | (17,608 | )
|Income tax benefit                                                                       |  |                             | 94      |   |      |   | 117     |  
|Minority interest in subsidiary loss                                                     |  |                             | 1,385   |   |      |   | 1,349   |  
|                                                                                         |  |                             |         |   |      |   |         |  
|                                                                                         |  |                            
|Net loss                                                                                 |  | $                           | (18,039 | ) |      | $ | (16,142 | )
|                                                                                         |  |                             |         |   |      |   |         |  
|                                                                                         |  |                            
|Basic and diluted net loss per share                                                     |  | $                           | (0.36   | ) |      | $ | (0.33   | )
|                                                                                         |  |                             |         |   |      |   |         |  
|                                                                                         |  |                            
|Weighted average number of shares used in computing basic and diluted net loss per share |  |                             | 49,803  |   |      |   | 49,159  |  
|                                                                                         |  |                             |         |   |      |   |         |  



See accompanying notes
to condensed consolidated financial statements



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CURAGEN CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                              |  |                              |         |   |      |   |         |  
|----------------------------------------------------------------------------- |  | ---------------------------- | ------- | - | ---- | - | ------- | -
|                                                                              |  | Three Months Ended March 31, |        
|                                                                              |  | 2004                         |         |   | 2003 |  
|Cash flows from operating activities:                                         |  |                              |         |   |      |   |         |  
|Net loss                                                                      |  | $                            | (18,039 | ) |      | $ | (16,142 | )
|Adjustments to reconcile net loss to net cash                                 |  |                              |         |   |      |   |         |  
|used in operating activities:                                                 |  |                              |         |   |      |   |         |  
|Depreciation and amortization                                                 |  |                              | 2,583   |   |      |   | 2,020   |  
|Non-monetary compensation                                                     |  |                              | 123     |   |      |   | 240     |  
|Stock-based 401(k) employer plan match                                        |  |                              | 244     |   |      |   | 244     |  
|Loss on extinguishment of debt                                                |  |                              | 294     |   |      |   |        |  
|Minority interest                                                             |  |                              | (1,385  | ) |      |   | (1,349  | )
|Changes in assets and liabilities:                                            |  |                              |         |   |      |   |         |  
|Income taxes receivable                                                       |  |                              | (94     | ) |      |   | 739     |  
|Other current assets                                                          |  |                              | (12     | ) |      |   | 117     |  
|Prepaid expenses                                                              |  |                              | (614    | ) |      |   | (610    | )
|Intangible and other assets, net                                              |  |                              | (22     | ) |      |   | (43     | )
|Accounts payable                                                              |  |                              | (2,088  | ) |      |   | 978     |  
|Accrued expenses                                                              |  |                              | 192     |   |      |   | (691    | )
|Accrued payroll and related items                                             |  |                              | (429    | ) |      |   | (1,508  | )
|Interest payable                                                              |  |                              | (1,901  | ) |      |   | (2,250  | )
|Deferred revenue                                                              |  |                              | (538    | ) |      |   | 208     |  
|Other current liabilities                                                     |  |                              | (251    | ) |      |   | (314    | )
|                                                                              |  |                              |         |   |      |   |         |  
|Net cash used in operating activities                                         |  |                              | (21,937 | ) |      |   | (18,361 | )
|                                                                              |  |                              |         |   |      |   |         |  
|                                                                              |  |                             
|Cash flows from investing activities:                                         |  |                              |         |   |      |   |         |  
|Acquisitions of property and equipment                                        |  |                              | (999    | ) |      |   | (923    | )
|Payments for intangible assets                                                |  |                              | (140    | ) |      |   | (328    | )
|Loans to employees, net of repayments                                         |  |                              | (42     | ) |      |   | (14     | )
|Net inflows from purchases and maturities of short-term investments           |  |                              | 42,206  |   |      |   | 36,300  |  
|Net inflows (outflows) from purchases and maturities of marketable securities |  |                              | 5,053   |   |      |   | (17,384 | )
|                                                                              |  |                              |         |   |      |   |         |  
|Net cash provided by investing activities                                     |  |                              | 46,078  |   |      |   | 17,651  |  
|                                                                              |  |                              |         |   |      |   |         |  
|                                                                              |  |                             
|Cash flows from financing activities:                                         |  |                              |         |   |      |   |         |  
|Payments on capital lease obligations                                         |  |                              | (147    | ) |      |   | (499    | )
|Proceeds from exercise of stock options                                       |  |                              | 210     |   |      |   | 36      |  
|Proceeds from issuance of convertible debt                                    |  |                              | 110,000 |   |      |   |        |  
|Payment for extinguishment of debt                                            |  |                              | (20,000 | ) |      |   |        |  
|Payments of financing costs                                                   |  |                              | (3,719  | ) |      |   |        |  
|                                                                              |  |                              |         |   |      |   |         |  
|Net cash provided by (used in) financing activities                           |  |                              | 86,344  |   |      |   | (463    | )
|                                                                              |  |                              |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                          |  |                              | 110,485 |   |      |   | (1,173  | )
|Cash and cash equivalents, beginning of period                                |  |                              | 42,843  |   |      |   | 68,401  |  
|                                                                              |  |                              |         |   |      |   |         |  
|Cash and cash equivalents, end of period                                      |  | $                            | 153,328 |   |      | $ | 67,228  |  
|                                                                              |  |                              |         |   |      |   |         |  
|Supplemental cash flow information:                                           |  |                              |         |   |      |   |         |  
|Interest paid                                                                 |  | $                            | 4,561   |   |      | $ | 4,538   |  
|Income tax benefit payments received                                          |  |                              |        |   |      | $ | 862     |  



See accompanying notes
to condensed consolidated financial statements



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CURAGEN CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)



|1. | Basis of Presentation
|-- | ---------------------



The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles
generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by
accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of our management, the accompanying unaudited condensed consolidated financial statements include all adjustments, consisting
of only normal recurring accruals, necessary to present fairly our consolidated financial position, results of operations and cash flows. Interim results are not necessarily indicative of the results that may be expected for the entire year. The
condensed consolidated financial statements of CuraGen Corporation and subsidiary (the Company) include CuraGen Corporation (CuraGen) and its majority-owned subsidiary, 454 Life Sciences Corporation (454), and
accordingly, all material intercompany balances and transactions have been eliminated.



The March 31, 2003 and December 31, 2003 condensed consolidated financial statements have been reclassified to conform to the
classifications used in 2004. All dollar amounts in tabular presentations are shown in thousands, except par value and per share data.



The accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial
statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2003.



|2. | Comprehensive Loss
|-- | ------------------



Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (SFAS 130), requires reporting
and displaying of comprehensive income and its components. In accordance with SFAS 130, the accumulated balance of other comprehensive loss is disclosed as a separate component of stockholders equity and is composed of unrealized gains and
losses on marketable securities.



A summary of
total comprehensive loss is as follows:



|                                                                 |  |                             |         |   |      |   |         |  
|---------------------------------------------------------------- |  | --------------------------- | ------- | - | ---- | - | ------- | -
|                                                                 |  | Three Months EndedMarch 31, |        
|                                                                 |  | 2004                        |         |   | 2003 |  
|Net loss                                                         |  | $                           | (18,039 | ) |      | $ | (16,142 | )
|                                                                 |  |                             |         |   |      |   |         |  
|Other comprehensive loss:                                        |  |                             |         |   |      |   |         |  
|Unrealized gains on securities:                                  |  |                             |         |   |      |   |         |  
|Unrealized holding gains arising during period                   |  |                             | 865     |   |      |   | 280     |  
|Less: reclassification adjustment for gains included in net loss |  |                             | 138     |   |      |   |        |  
|                                                                 |  |                             |         |   |      |   |         |  
|Net unrealized gains on securities                               |  |                             | 727     |   |      |   | 280     |  
|                                                                 |  |                             |         |   |      |   |         |  
|Total comprehensive loss                                         |  | $                           | (17,312 | ) |      | $ | (15,862 | )
|                                                                 |  |                             |         |   |      |   |         |  



|3. | Stock-Based Compensation
|-- | ------------------------



In October 1995, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation (SFAS 123), which was effective beginning January 1, 1996. SFAS 123 requires expanded disclosures of stock-based compensation arrangements with employees and non-employees and
encourages (but does not require) compensation cost to be measured based on the fair value of the equity instruments awarded to employees. Companies are permitted to continue to apply Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees (APB 25), which recognizes compensation cost based on the intrinsic value of the equity instruments awarded. The Company will continue to apply APB 25 to its stock-based compensation awards to employees.



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Had compensation cost for the Companys stock option plans been determined in
accordance with SFAS 123, net loss and net loss per share would have approximated the pro forma amounts shown below for each of the three month periods ended March 31, 2004 and 2003.



|                                                                                                    |  |                             |         |   |      |   |         |  
|--------------------------------------------------------------------------------------------------- |  | --------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                                    |  | Three Months EndedMarch 31, |        
|                                                                                                    |  | 2004                        |         |   | 2003 |  
|Net loss, as reported                                                                               |  | $                           | (18,039 | ) |      | $ | (16,142 | )
|Stock-based employee compensation expense included in net loss                                      |  |                             | 97      |   |      |   | 231     |  
|Total stock-based employee compensation expense determined under Black-Scholes option pricing model |  |                             | (2,432  | ) |      |   | (3,159  | )
|                                                                                                    |  |                             |         |   |      |   |         |  
|Pro forma net loss                                                                                  |  | $                           | (20,374 | ) |      | $ | (19,070 | )
|                                                                                                    |  |                             |         |   |      |   |         |  
|Basic and diluted net loss per share:                                                               |  |                             |         |   |      |   |         |  
|As reported                                                                                         |  | $                           | (0.36   | ) |      | $ | (0.33   | )
|Pro forma                                                                                           |  | $                           | (0.41   | ) |      | $ | (0.39   | )



|4. | Restructuring and Related Charges
|-- | ---------------------------------



In June 2003, the Company announced a restructuring plan intended to focus resources on continuing to advance its broad pipeline of
protein, antibody, and small molecule therapeutics into preclinical and clinical development. In connection with this restructuring plan, a charge of approximately $2.9 million was recorded in the second quarter of 2003, including $1.8 million
related to employee separation costs, $1.0 million of operating lease obligations and $0.1 million of asset impairment costs. The cash requirements under the June 2003 restructuring plan were $2.7 million, of which $1.7 million was paid prior to
March 31, 2004. The remaining cash requirements of $1.0 million will be paid through the end of 2008.



|5. | Segment Reporting
|-- | -----------------



The Company currently operates in two business segments: CuraGen and 454. CuraGen is a genomics-based pharmaceutical company, dedicated to
improving the lives of patients by developing a pipeline of novel protein, antibody, and small molecule therapeutics in the areas of oncology, inflammation, obesity and diabetes, and central nervous system disorders. 454, the Companys
majority-owned subsidiary, is developing novel nanoscale instrumentation and technologies for rapidly and comprehensively determining the nucleotide sequencewhole genome sequencingof entire genomes. The operations of 454 are
run by a separate management team and governed by a separate Board of Directors made up of members of CuraGens management team and Board of Directors. The Company currently exceeds the quantitative thresholds described above governing segment
reporting, and as a result, the financial information disclosed herein represents all of the material financial information related to the Companys reportable business segments. All of the Companys revenues are generated in the United
States and all assets are located in the United States.



|                          |  |               |         |   |                  |   |         |  
|------------------------- |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                          |  | March 31,2004 |         |   | December 31,2003 |  
|Cash and investments:     |  |               |         |   |                  |   |         |  
|CuraGen                   |  | $             | 387,742 |   |                  | $ | 319,444 |  
|454                       |  |               | 19,852  |   |                  |   | 24,197  |  
|                          |  |               |         |   |                  |   |         |  
|Total                     |  | $             | 407,594 |   |                  | $ | 343,641 |  
|                          |  |               |         |   |                  |   |         |  
|Total assets:             |  |               |         |   |                  |   |         |  
|CuraGen                   |  | $             | 434,584 |   |                  | $ | 365,906 |  
|454                       |  |               | 28,698  |   |                  |   | 33,260  |  
|Intercompany eliminations |  |               | (19,606 | ) |                  |   | (22,209 | )
|                          |  |               |         |   |                  |   |         |  
|Total                     |  | $             | 443,676 |   |                  | $ | 376,957 |  
|                          |  |               |         |   |                  |   |         |  



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|                                     |  |                              |        |   |      |   |        |  
|------------------------------------ |  | ---------------------------- | ------ | - | ---- | - | ------ | -
|                                     | 
|                                     |  | Three Months Ended March 31, |       
|                                     |  | 2004                         |        |   | 2003 |  
|Revenues:                            |  |                              |        |   |      |   |        |  
|CuraGen                              |  | $                            | 1,512  |   |      | $ | 1,944  |  
|454                                  |  |                              | 108    |   |      |   |       |  
|Intercompany eliminations            |  |                              | (5     | ) |      |   |       |  
|                                     |  |                              |        |   |      |   |        |  
|Total                                |  | $                            | 1,615  |   |      | $ | 1,944  |  
|                                     |  |                              |        |   |      |   |        |  
|Operating expenses:                  |  |                              |        |   |      |   |        |  
|CuraGen                              |  | $                            | 15,767 |   |      | $ | 15,966 |  
|454                                  |  |                              | 4,231  |   |      |   | 3,444  |  
|                                     |  |                              |        |   |      |   |        |  
|Total                                |  | $                            | 19,998 |   |      | $ | 19,410 |  
|                                     |  |                              |        |   |      |   |        |  
|Net loss:                            |  |                              |        |   |      |   |        |  
|CuraGen                              |  | $                            | 15,384 |   |      | $ | 14,118 |  
|454                                  |  |                              | 4,040  |   |      |   | 3,373  |  
|Minority interest in subsidiary loss |  |                              | (1,385 | ) |      |   | (1,349 | )
|                                     |  |                              |        |   |      |   |        |  
|Total                                |  | $                            | 18,039 |   |      | $ | 16,142 |  
|                                     |  |                              |        |   |      |   |        |  
|Capital expenditures:                |  |                              |        |   |      |   |        |  
|CuraGen                              |  | $                            | 728    |   |      | $ | 598    |  
|454                                  |  |                              | 286    |   |      |   | 455    |  
|Intercompany eliminations            |  |                              | (15    | ) |      |   | (130   | )
|                                     |  |                              |        |   |      |   |        |  
|Total                                |  | $                            | 999    |   |      | $ | 923    |  
|                                     |  |                              |        |   |      |   |        |  
|Depreciation and amortization:       |  |                              |        |   |      |   |        |  
|CuraGen                              |  | $                            | 1,991  |   |      | $ | 1,692  |  
|454                                  |  |                              | 592    |   |      |   | 328    |  
|                                     |  |                              |        |   |      |   |        |  
|Total                                |  | $                            | 2,583  |   |      | $ | 2,020  |  
|                                     |  |                              |        |   |      |   |        |  



|6. | 4% Convertible Subordinated Notes Due in 2011
|-- | ---------------------------------------------



On February 17, 2004, the Company completed an offering of $100.0 million of 4% convertible subordinated notes due February 15, 2011 and
received net proceeds of approximately $97.0 million. In addition, on March 16, 2004, the initial purchasers exercised their option to purchase an additional $10.0 million of 4% convertible subordinated notes due February 15, 2011, providing the
Company with additional net proceeds of approximately $9.7 million. The notes may be resold by the initial purchasers to qualified institutional buyers under Rule 144A of the Securities Act and to non-U.S. persons outside the United States under
Regulation S under the Securities Act. Holders may convert their notes into shares of the Companys common stock at any time prior to maturity or their prior redemption or repurchase by the Company at a conversion price of approximately $9.69
per share of common stock, subject to adjustment in certain circumstances.



In addition, during the period commencing February 18, 2009, to and including February 14, 2010, the Company has the right to redeem the notes at a redemption price equal to 101.143% of the principal amount of the
notes plus accrued and unpaid interest, if any, to, but not including, the redemption date; and beginning on February 15, 2010, the Company has the right to redeem the notes at a redemption price equal to 100.571% of the principal amount of the
notes plus accrued and unpaid interest, if any, to, but not including, the redemption date. The Company will pay cash interest on the notes on February 15 and August 15 of each year, beginning on August 15, 2004. Pursuant to the obligations under
the convertible subordinated note agreement, the Company filed a registration statement with the Securities and Exchange Commission on March 25, 2004 for the resale of any shares issued as a result of the conversion of the notes.



|7. | Extinguishment of Debt
|-- | ----------------------



On February 17, 2004, the Company repurchased $20.0 million of its 6% convertible subordinated debentures due in 2007, for total
consideration of $20.0 million, plus accrued interest of $0.05 million to the date of repurchase. As a result of the transaction, and in accordance with Statement of Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections, in February 2004, the Company recorded a loss of approximately $0.3 million in Loss on extinguishment of debt, which includes the write-off of the ratable
portion of unamortized deferred financing costs relating to the repurchased debt.



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CURAGEN CORPORATION AND SUBSIDIARY



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations



This Managements Discussion and Analysis of Financial Condition and Results of Operations as of March 31, 2004 and for the three month periods ended
March 31, 2004 and 2003 should be read in conjunction with the sections of our audited condensed consolidated financial statements and notes thereto as well as our Managements Discussion and Analysis of Financial Condition and Results of
Operations that are included in our Annual Report on Form 10-K for the year ended December 31, 2003.



Overview



We are a genomics-based pharmaceutical development company dedicated to improving the lives of patients by developing novel protein, antibody and small
molecule therapeutics in the areas of oncology, inflammatory diseases, obesity and diabetes, and central nervous system disorders. Our pipeline of therapeutics is based on targets from the human genome that we believe play a role in important
mechanisms underlying disease.



We have taken a systematic
approach to identifying and validating the most promising therapeutic targets from the human genome that are both applicable and amenable to drug development. We use internal resources to develop our protein therapeutics and have established
development alliances with Abgenix, Inc. (Abgenix) to support our antibody projects and Bayer AG (Bayer) to support small molecule projects.



As our pipeline has matured over the past few years, we have decreased our early-stage target discovery efforts and focused
our resources on the advancement of our pipeline of protein, antibody and small molecule therapeutics into clinical development. In 2003, we received U.S. Food and Drug Administration (FDA) clearance to conduct Phase I clinical trials
for CG53135, a potential protein therapeutic for oral mucositis in cancer patients that are undergoing chemotherapy and radiotherapy. During 2004 we continued to make progress on the development of CG53135 for oral mucositis, including the
initiation of an additional clinical study. In April 2004, we initiated an additional Phase I study of CG53135 in cancer patients undergoing bone marrow transplantation which complements the first Phase I study in colorectal cancer patients, since
CG53135 is being investigated for the prevention and treatment of oral mucositis in patients with solid tumors, such as colorectal cancer, as well as in patients with hematologic tumors, such as the ones that require bone marrow transplantation. We
anticipate that this Phase I study in cancer patients undergoing bone marrow transplantation will help build momentum for a Phase II study in 2004 in this same patient population.



In February 2004, we received orphan drug designation from the FDA for CG53135 in oral mucositis, which we believe will help
to strengthen the program by offering important clinical development and commercialization benefits. In March 2004, we also presented animal model data at the 95thAnnual Meeting of the American Association for Cancer Research (AACR) that highlights the potential of this molecule and differentiates it from competing products, by demonstrating that a single dose
of CG53135 can protect tissue from radiation injury, which may translate into clinical benefits and enhanced dosing flexibility. The potency of CG53135 is believed to be due to the molecules activity on two critical layers of cells (epithelial
and mesenchymal) present in the mucosa lining of the mouth and the remainder of a patients gastrointestinal tract. CR002, which is the most advanced fully-human monoclonal antibody stemming from our collaboration with Abgenix, is currently in
preclinical development and we anticipate filing an investigational new drug application (IND) for, and initiating clinical trials of, CR002 later this year. CR002 is a novel fully-human monoclonal antibody with the potential to treat
forms of kidney inflammation that if left untreated could progress to kidney failure. In addition to CG53135 and CR002, we have over 15 potential protein, antibody and small molecule therapeutics currently being evaluated in animal studies or being
prepared for animal studies. Many of the INDs that we anticipate filing in the future will be identified from these programs.



To enable us to focus on our pipeline, we announced the formation of 454 Life Sciences Corporation (454) in June 2000. This majority-owned
subsidiary is developing novel nanoscale instrumentation and technologies for rapidly and comprehensively determining the nucleotide sequence  whole genome sequencing  of entire genomes. 454s proprietary technology is
expected to have widespread applications in industrial processes, agriculture, animal health, biodefense, human health care, including drug discovery and development, and disease diagnosis. Currently, 454 is focusing on the analysis of viruses and
bacteria and anticipates that it will begin scaling its technology to further analyze fungi, larger model organisms, human DNA, and other genomic applications during 2004. 454 plans to sell both genomic analysis services and complete genomic
analysis systems, including instrumentation, reagents and software to end-users. 454 recognized revenue related to its first genomic analysis services during the first quarter of 2004.



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We expect to generate value for our shareholders by developing genomics-based therapeutics. We expect to
become profitable by commercializing a subset of therapeutics stemming from our development pipeline, and establishing partnerships with pharmaceutical and biotechnology companies for the co-development and co-commercialization of other therapeutics
from our development pipeline. Our failure to successfully develop pharmaceutical products that we can commercialize would materially adversely affect our business, financial condition and results of operations. Royalties or other revenue generated
from commercial sales of products developed through the application of our technologies and expertise are not expected for several years, if at all. We expect that our revenue or income sources for at least the next several years may be limited to:
interest income; payments under various collaboration agreements to the extent milestones are met; royalty payments from collaborators under existing or future arrangements (to the extent that we enter into any future arrangements); and 454 service
and product revenue (which is expected in 2004, as 454s technology is commercialized and its applications across the life sciences industry become accepted).



We expect to continue to incur substantial expenses relating to our research and development efforts, as we focus on:
preclinical studies and clinical trials required for the development of therapeutic protein, antibody and small molecule product candidates; external programs identified by our platform as being promising and synergistic with our products and
expertise; and 454, as it continues work on the development and commercialization of its technology for whole genome analysis. Conducting clinical trials is a lengthy, time-consuming and expensive process. We will incur substantial expenses for, and
devote a significant amount of time to, these studies. As a result, we expect to incur continued and increasing losses over the next several years, unless we are able to realize additional revenues under existing or new collaboration agreements or
through 454s sales of genomic analysis services and/or complete genomic analysis systems. The timing and amounts of such revenues, if any, cannot be predicted with certainty and may fluctuate. Results of operations for any period may be
unrelated to the results of operations for any other period. In addition, historical results should not be viewed as indicative of future operating results.



The 2003 condensed consolidated financial statements have been reclassified to conform to the classifications used in 2004. All dollar amounts in tabular
presentations are shown in thousands, unless otherwise noted.



Critical
Accounting Policies and Use of Estimates



The discussion
and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The
preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, and revenues and expenses, and as such, actual results may differ from our estimates under
different assumptions or conditions. Our significant accounting policies are fully described in Note 1 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2003.



10



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##### Table of Contents

Results of Operations



The following table sets forth a comparison of the components of our net loss for the periods ended March 31, 2004 and 2003 (in millions):



|                                     |  |      |      |      |   |         |  |   |         |   |  |     |   
|------------------------------------ |  | ---- | ---- | ---- | - | ------- |  | - | ------- | - |  | --- | --
|                                     |  | 2004 |      | 2003 |   | $Change |  |   | %Change |  
|Collaboration revenue                |  | $    | 1.6  |      | $ | 1.9     |  | $ | (0.3    | ) |  | (16 | )%
|Research and development expenses    |  |      | 15.1 |      |   | 14.5    |  |   | 0.6     |   |  | 4   | % 
|General and administrative expenses  |  |      | 4.8  |      |   | 4.9     |  |   | (0.1    | ) |  | (2  | )%
|Interest income                      |  |      | 2.0  |      |   | 2.3     |  |   | (0.3    | ) |  | (1  | )%
|Interest expense                     |  |      | 2.9  |      |   | 2.4     |  |   | 0.5     |   |  | 21  | % 
|Loss on extinguishment of debt       |  |      | 0.3  |      |   |        |  |   | 0.3     |   |  | *   |   
|Income tax benefit                   |  |      | 0.1  |      |   | 0.1     |  |   |        |   |  |    |   
|Minority interest in subsidiary loss |  |      | 1.4  |      |   | 1.4     |  |   |        |   |  |    |   
|                                     |  |      |      |      |   |         |  |   |         |   |  |     |   
|Net loss                             |  |      | 18.0 |      |   | 16.1    |  |   | 1.9     |   |  | 12  | % 
|                                     |  |      |      |      |   |         |  |   |         |   |  |     |   

---

|* | Less than 1%
|- | ------------



Collaboration revenue. The decrease in collaboration revenue for the three months ended March 31, 2004 was primarily a result of a decline
in revenue recognized from various strategic alliances and the on-going change in our business strategy, which is to commercialize therapeutics from our development pipeline, rather than focusing on short-term revenue generating service-based
collaborations. We expect that 2004 collaboration revenue will remain fairly constant as compared to 2003, reflecting continued progress of the Bayer alliance and various other collaborations, as well as the inclusion of nominal revenues expected
from the commercialization of 454s new technology.



Research and development expenses.



The following table sets forth a comparison of research and development expenses by segment, for the periods ended March 31, 2004 and 2003 (in millions):



|                                   |  |      |      |      |      |         |     |         |    |  
|---------------------------------- |  | ---- | ---- | ---- | ---- | ------- | --- | ------- | -- | -
|                                   |  | 2004 |      | 2003 |      | $Change |     | %Change |   
|Research and development expenses: |  |      |      |      |      |         |     |         |    |  
|CuraGen                            |  | $    | 12.0 |      | 11.7 |         | 0.3 |         | 3  | %
|454                                |  |      | 3.1  |      | 2.8  |         | 0.3 |         | 11 | %
|                                   |  |      |      |      |      |         |     |         |    |  
|Total                              |  |      | 15.1 |      | 14.5 |         |     |         |    |  
|                                   |  |      |      |      |      |         |     |         |    |  



The increase in
research and development expenses for CuraGen for the three months ended March 31, 2004 was primarily due to an increase in contractual services related to our preclinical studies and clinical trials, offset by a reduction of prior year accruals
related to payments subsequently determined to be no longer owed due to amended contract terms for the Abgenix collaboration. We anticipate that research and development expenses will increase in 2004 as we continue to advance our pipeline of
protein, antibody, and small molecule therapeutics.



The
increase in research and development expenses for 454 for the three months ended March 31, 2004 was primarily due to increased personnel costs and depreciation expense associated with developing a measurement service center and manufacturing
capabilities in connection with the preparation for commercialization of 454s technology. We anticipate that 454s research and development expenses will continue to increase in 2004 in connection with further improvements of its
technology.



General and administrative expenses.
General and administrative expenses for the three months ended March 31, 2004 remained relatively consistent with the same period in 2003. General and administrative expenses are expected to increase slightly in 2004.



Interest income. Interest income for the three months ended
March 31, 2004 decreased primarily due to lower yields in our investment portfolio and a decrease in cash and investment balances during 2003 and a portion of the first quarter of 2004. We earned an average yield of 2.0% in the first quarter of 2004
as compared to 2.4% in the first quarter of 2003. During 2004, we anticipate that interest income will decrease by approximately $1.0 million as compared to 2003, as a result of the utilization of cash and investment balances in the normal course of
operations and the repurchase of $20.0 million of our 6% convertible subordinated debentures due in 2007, offset by the receipt of net proceeds of approximately $106.0 million from our 4% convertible subordinated notes due in 2011. However, in the
event that later in 2004 we use cash to repay a portion of our remaining existing debt due in 2007, our anticipation of the decrease in interest income for 2004 will differ accordingly. During the remainder of 2004, we expect the yields in our
investment portfolio to be consistent with the first quarter of 2004.



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Interest expense. We expect interest expense to increase to approximately $13.0 million
during 2004, attributable to the interest to be paid semi-annually to the holders of our $110.0 million 4% convertible subordinated notes due in 2011, offset by a decrease in interest expense related to the repurchase of $20.0 million of the 6%
convertible subordinated debentures due in 2007.



Loss on
extinguishment of debt.In February 2004, we repurchased $20.0 million of our 6% convertible subordinated debentures due in 2007, for total consideration of $20.0 million, plus accrued interest of $0.05 million to the date of repurchase. As
a result of the transaction, and in accordance with SFAS 145, we recorded a loss of approximately $0.3 million in Loss on extinguishment of debt, which includes the write-off of the ratable portion of unamortized deferred financing costs
relating to the repurchased debt.



Minority interest in
subsidiary loss. Minority interest in subsidiary loss for the three months ended March 31, 2004 (which is the portion of 454s loss attributable to shareholders of 454 other than us) remained consistent with the same period in 2003.
During 2004, losses attributed to the minority ownership in 454 are expected to remain fairly constant as compared to 2003, as 454 continues to make progress towards commercializing and developing new technologies.



Liquidity and Capital Resources



Since our inception, we have financed our operations and met our capital
expenditure requirements primarily through public equity offerings, private placements of equity securities, convertible subordinated debt offerings, revenues received under our collaborative research agreements and government grants, capital leases
and exercises of stock options. On February 17, 2004, we completed an offering of $100.0 million of 4% convertible subordinated notes due February 15, 2011, and received net proceeds of approximately $97.0 million. In addition, on March 16, 2004,
the initial purchasers exercised their option to purchase an additional $10.0 million of 4% convertible subordinated notes due February 15, 2011, providing us with additional net proceeds of approximately $9.7 million. On February 17, 2004, we
repurchased $20.0 million of our 6% convertible subordinated debentures due in 2007, for total consideration of $20.0 million, plus accrued interest of $0.05 million to the date of repurchase. As of March 31, 2004, we had recognized $107.6 million
of cumulative sponsored research revenues from collaborative research agreements and government grants. At March 31, 2004, our gross investment in lab and office equipment, computers, land and leasehold improvements was $48.0 million, and equipment
with a gross book value of $1.0 million secured our capital lease facilities. Since inception, we have not had any off-balance sheet arrangements. To date, inflation has not had a material effect on our business.



Cash and investments.The following table depicts the
components of our operating, investing and financing activities for the quarter ended March 31, 2004, using the direct cash flow method (in millions):



|                                                                        |  |   |       |  
|----------------------------------------------------------------------- |  | - | ----- | -
|Cash received from collaborators                                        |  | $ | 1.1   |  
|Cash paid to suppliers and employees                                    |  |   | (20.3 | )
|Restructuring and related charges paid                                  |  |   | (0.2  | )
|Interest income received                                                |  |   | 2.0   |  
|Interest expense paid                                                   |  |   | (4.5  | )
|                                                                        |  |   |       |  
|Net cash and investments used in operating activities                   |  |   | (21.9 | )
|                                                                        |  |   |       |  
|                                                                        | 
|Cash paid to acquire property and equipment, net of sales proceeds      |  |   | (1.0  | )
|Cash paid to acquire intangible assets                                  |  |   | (0.2  | )
|                                                                        |  |   |       |  
|Net cash and investments used in investing activities                   |  |   | (1.2  | )
|                                                                        |  |   |       |  
|                                                                        | 
|Cash paid for principal portion of capital leases                       |  |   | (0.1  | )
|Cash received from issuance of convertible debt, net of financing costs |  |   | 106.3 |  
|Cash paid for extinguishment of debt                                    |  |   | (20.0 | )
|Cash received from employee stock option exercises                      |  |   | 0.2   |  
|                                                                        |  |   |       |  
|Net cash and investments provided by financing activities               |  |   | 86.4  |  
|                                                                        |  |   |       |  
|Unrealized gain on marketable securities                                |  |   | 0.7   |  
|                                                                        |  |   |       |  
|                                                                        | 
|Net increase in cash and investments                                    |  |   | 64.0  |  
|Cash and investments, beginning of period                               |  |   | 343.6 |  
|                                                                        |  |   |       |  
|Cash and investments, end of period                                     |  | $ | 407.6 |  
|                                                                        |  |   |       |  



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The increase in cash and investments during the first quarter of 2004 was primarily a result of the
receipt of net proceeds of approximately $106.7 million from our 4% convertible subordinated notes due in 2011, offset by the repurchase of $20.0 million of our 6% convertible subordinated debentures due in 2007, additional operating losses in
support of our research and development activities, and acquisitions of additional property and equipment and intangible assets.



In accordance with our investment policy, we are utilizing the following investment objectives for cash and investments: (1) investment decisions are made
with the expectation of minimum risk of principal loss, even with a modest penalty in yield; (2) appropriate cash balances and related short-term funds are maintained for immediate liquidity needs, and appropriate liquidity is available for
medium-term cash needs; and (3) maximum after-tax yield is achieved.



Future Liquidity



Sources of
Liquidity. During 2004, we expect to continue to fund our operations through a combination of the following sources: cash and investment balances; interest income; collaboration revenue; and potential public securities offerings and/or private
strategic-driven common stock offerings.



Uses of
Liquidity. Throughout 2004, we plan to continue making substantial investments in our emerging preclinical and clinical drug pipeline. In that regard, we foresee the following as significant uses of liquidity: personnel costs; supplies and
reagents; clinical trial related costs such as contractual services and manufacturing costs; and capital expenditures. These costs will be incurred primarily in connection with the following preclinical and clinical efforts: ongoing clinical trial
costs and anticipated Phase II manufacturing costs beginning in 2004 on our protein therapeutic CG53135 in the area of oral mucositis; costs related to our manufacturing agreement with Abgenix for CR002; toxicology costs to support our planned
submission of an IND for CR002; preclinical and clinical costs in connection with the use of our protein therapeutic CG53135 to treat alternative clinical indications; external programs identified by our platform as being promising and synergistic
with our products and expertise; and legal expenses in support of the continued protection of our intellectual property portfolio. In addition, we expect that payment of interest to the holders of our convertible subordinated debt due in 2007 and in
2011 to be a significant use of liquidity.



Depending on market
and other conditions, from time to time, we may repurchase a portion of the remainder of our existing notes due in 2007 in open market purchases, in privately negotiated transactions, or otherwise. In addition, we will use cash and investments for
working capital, general corporate purposes and potentially for future acquisitions of complementary businesses or technologies. The amounts and timing of our actual expenditures will depend upon numerous factors, including the amount and extent of
our acquisitions, our product development activities, our investments in technology and the amount of cash generated by our operations. Actual expenditures may vary substantially from our estimates. Our failure to use such funds effectively could
have a material adverse effect on our business, results of operations and financial condition. We anticipate that we will also incur significant capital expenditures in 2004, primarily for the expansion of our existing protein production laboratory
facilities, in addition to the purchase of equipment and leasehold improvements at both our and 454s research facilities and administrative offices.



We believe that our existing cash and investment balances and other sources of liquidity will be sufficient to meet our requirements for the next
twenty-four months. Our operating and capital expenditures are considered to be crucial to our future success, and by continuing to make strategic investments in our preclinical and clinical drug pipeline, we believe that we are building substantial
value for our shareholders. The adequacy of our available funds to meet our future operating and capital requirements, including the repayment of our remaining $130.0 million of 6% convertible subordinated debentures due February 2, 2007 and our
$110.0 million of 4% convertible subordinated notes due February 15, 2011, will depend on many factors. These factors include: the number, breadth and progress of our research, product development and clinical programs; the costs and timing of
obtaining regulatory approvals for any of our products; in-licensing of pharmaceutical products; costs incurred in enforcing and defending our patent claims and other intellectual property rights; and potential future acquisitions of complementary
businesses or technologies.



While we will continue to explore
alternative sources for financing our business activities, including the possibility of public securities offerings and/or private strategic-driven common stock offerings, we cannot be certain that in the future these sources of liquidity will be
available when needed or that our actual cash requirements will not be greater than anticipated. In appropriate strategic situations, we may seek financial assistance from other sources, including contributions by others to joint ventures and other
collaborative or licensing arrangements for the development and testing of products under development. However, should we be unable to obtain future financing either through the methods described above or through other means, we may be unable to
meet the critical objective of our long-term business plan, which is to successfully develop and market pharmaceutical products.



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Minority Interest in Subsidiary



As of March 31, 2004, minority interest in subsidiary was $6.8 million.
Minority interest in subsidiary is related to 454 and reflects the minority shareholders capitalization, less a gain recognition of $3.9 million as a result of our contribution of technology to 454 in 2000, and less the minority
shareholders portion of losses incurred to date. The loss attributed to the minority ownership in 454 is expected to remain fairly constant during 2004, as 454 continues to make progress towards commercializing and developing new technologies.



Certain Factors That May Affect Results of Operations



This report contains certain forward-looking statements. Generally, these
statements can be identified by the use of terms such as estimate, project, plan, intend, expect, believe, anticipate, should, may,
will, and similar expressions. Forward-looking statements may include statements about: (i) our ability to pay the remaining cash requirements of $1.0 million through the end of 2008 as part of our June 2003 restructuring plan, (ii) our
expectation that our Phase I study of CG53135 in cancer patients undergoing bone marrow transplantation will help build momentum for a Phase II study in 2004 in this same patient population, (iii) our expectation of filing an investigational new
drug application (IND) for, and initiating clinical trials of, CR002 later this year, (iv) our expectation that many of the INDs that we plan to file in the future will be identified from our animal studies, (v) the expectation that
454s proprietary technology will have widespread applications in industrial processes, agriculture, animal health, biodefense, human health care, including drug discovery and development, and disease diagnosis, (vi) the ability of 454 to scale
its technology to further analyze fungi, larger model organisms, human DNA, and other genomic applications during 2004, (vii) the ability of 454 to sell both genomic analysis services and complete genomic analysis systems, including instrumentation,
reagents and software to end-users, (viii) the ability of 454 to generate product revenue in 2004, (ix) our ability to generate value for our shareholders by focusing our resources on developing genomics-based therapeutics to improve the lives of
patients, (x) our expectation to become profitable by commercializing a subset of therapeutics stemming from our development pipeline, and establishing partnerships with pharmaceutical and biotechnology companies for the co-development and
co-commercialization of therapeutics from our development pipeline, (xi) our expectation to continue to incur substantial expenses relating to our research and development efforts, (xii) our expectation that 2004 collaboration revenue will remain
fairly constant as compared to 2003, (xiii) our expectation that research and development expenses will continue to increase in 2004, (xiv) our expectation that general and administrative expenses will increase slightly in 2004, (xv) our expectation
that interest income will decrease by approximately $1.0 million overall as compared to 2003, (xvi) our expectation that the 2004 yields in our investment portfolio will be consistent with the first quarter of 2004, (xvii) our expectation that
interest expense will increase to approximately $13.0 million during 2004, (xviii) our expectation that losses attributed to the minority ownership in 454 will remain fairly constant as compared to 2003, (xix) our plan to continue making substantial
investments in our emerging preclinical and clinical drug pipeline throughout 2004, (xx) our expectation that we will incur significant capital expenditures in 2004, primarily for the expansion of our existing protein production laboratory
facilities, in addition to the purchase of equipment and leasehold improvements at both our and 454s research facilities and administrative offices, and (xxi) our belief that our existing cash and investment balances and other sources of
liquidity will be sufficient to meet our requirements for the next twenty-four months.



These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. Forward-looking statements,
therefore, should be considered in light of all of the information included or referred to in this report, including the cautionary information set forth under the heading Risk Factors below. We disclaim any intention or obligation to update or
revise any forward-looking statements, whether as a result of new information, future events, or otherwise, unless required by law.



Risk Factors



Risks Related to Our Business



Because our business strategy is still largely untested, we do not know whether we will be able to commercialize any of our products or to what extent we will generate revenue or become profitable.



We do not know whether we can implement our business strategy successfully
because we are in the early stages of development. Initially, we set out to find as many genes and their related functions as possible and are now using that information to develop our own therapeutic products. This strategy is largely untested.
Other companies first target particular diseases and try to find cures for them, have a limited number of genes and proteins of potential



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therapeutic interest, or rely on other more proven strategies. If our strategy does not result in the development of
products that we can commercialize, we will be unable to generate revenue. We have not completed development of any product based on our genomics research. Although our first potential product has entered clinical trials, we cannot be certain that
this or any future products will receive marketing approval. If we are unable to commercialize products, we may not be able to recover our investment in our product development efforts.



Because clinical trials for our products will be expensive and protracted and their outcome is uncertain, we must invest substantial
amounts of time and money that may not yield viable products.



Conducting clinical trials is a lengthy, time-consuming and expensive process. Before obtaining regulatory approvals for the commercial sale of any product, we must demonstrate through laboratory, animal and human studies that such product
is both effective and safe for use in humans. Preclinical drug candidate testing and clinical drug trials can often go on for an undetermined period of time in the sense that testing and trials are continually monitored, with each test or trial
considered complete only when sufficient data has been accumulated to assess whether the next phases are warranted or whether the effort should be abandoned. Many factors may delay the commencement and speed of completion of preclinical
drug candidate testing and clinical drug trials, including the size and number of patients participating in the trial, the duration of patient follow-up required, the number of clinical sites at which the trials are conducted, and the length of time
required to locate and enroll suitable patient subjects. We will incur substantial expense for, and devote a significant amount of time to, these studies.



Completion of clinical trials may take many years. The length of time required varies substantially according to the type, complexity, novelty and
intended use of the product candidate. The FDA monitors the progress of each phase of testing, and may require the modification, suspension, or termination of a trial if it is determined to present excessive risks to patients. Our rate of
commencement and completion of clinical trials may be delayed by many factors, including:



| |  | our inability to manufacture sufficient quantities of materials for use in clinical trials;
| | - | -------------------------------------------------------------------------------------------



| |  | variability in the number and types of patients available for each study, as well as the difficulty in enrolling patients in each study;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------



| |  | difficulty in maintaining contact with patients after treatment, resulting in incomplete data;
| | - | ----------------------------------------------------------------------------------------------



| |  | unforeseen safety issues or side effects;
| | - | -----------------------------------------



| |  | poor or unanticipated effectiveness of products during the clinical trials;
| | - | ---------------------------------------------------------------------------



| |  | institutional review board delays at institutions assisting us with our clinical trials; and
| | - | --------------------------------------------------------------------------------------------



| |  | government or regulatory delays.
| | - | --------------------------------



Studies that we conduct, or studies which third parties conduct on our behalf, may not demonstrate sufficient effectiveness and safety to obtain the
requisite regulatory approvals for these or any other potential products. Regulatory authorities may not permit us to undertake any additional clinical trials. The clinical trial process may be accompanied by substantial delay and expense and there
can be no assurance that the data generated in these studies ultimately will be sufficient for marketing approval by the FDA.



We have only one product in clinical development and our other products are in preclinical development. None of these products may demonstrate sufficient
effectiveness or safety to obtain the requisite regulatory approvals required for initiation or continuation of clinical studies or obtaining marketing approval.



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Because we have limited experience in developing, commercializing and marketing products, we may be unsuccessful in
our efforts to do so.



Currently, we are developing
several potential pharmaceutical products, and such products will require significant research and development and preclinical testing, and will require extensive clinical testing prior to our submitting any regulatory application for their
commercial use. Although we are conducting human studies with respect to one product, we have limited experience with these activities and may not be successful in developing or commercializing these or other products. These activities, if
undertaken without the collaboration of others, will require the expenditure of significant funds. Such potential pharmaceutical products will be subject to the risks of failure inherent in the development of pharmaceutical products based on new
technologies. Before we can commercialize a product, we must rigorously test the product in the laboratory and complete extensive human studies. Even if we complete such studies, our ability to develop and commercialize products will depend on our
ability to:



| |  | complete laboratory testing and human studies;
| | - | ----------------------------------------------



| |  | obtain and maintain necessary intellectual property rights to our products;
| | - | ---------------------------------------------------------------------------



| |  | obtain and maintain necessary regulatory approvals related to the efficacy and safety of our products;
| | - | ------------------------------------------------------------------------------------------------------



| |  | enter into arrangements with third parties to manufacture our products on our behalf; and
| | - | -----------------------------------------------------------------------------------------



| |  | deploy sales and marketing resources effectively or enter into arrangements with third parties to provide these functions.
| | - | --------------------------------------------------------------------------------------------------------------------------



As a result of these possibilities, we may not be able to develop through our
research and development activities any commercially viable products. We cannot be certain that expenses for testing and study will yield profitable products or even products approved for marketing by the FDA. If we are not successful in identifying
products that we can develop commercially, we may be unable to recover the large investment we have made in research, development and manufacturing. In addition, should we choose to develop pharmaceutical products internally, we will have to make
significant investments in pharmaceutical product development, marketing, sales and regulatory compliance resources, and we will have to establish or contract for the manufacture of products under the current good manufacturing practices
(cGMPs) of the FDA. Any potential products developed by our licensees will be subject to the same risks.



We do not have any marketed products. If we develop products that can be marketed, we intend to market the products either independently or together with
collaborators or strategic partners. If we decide to market any products independently, we will incur significant additional expenditures and commit significant additional management resources to establish a sales force. For any products that we
market together with partners, we will rely, in whole or in part, on the marketing capabilities of those parties. We may also contract with third parties to market certain of our products. Ultimately, we and our partners may not be successful in
marketing our products.



We depend on a limited number of suppliers and
depend on them to manufacture and supply critical components of our development and clinical programs.



Currently, we contract with third-party manufacturers or develop products with partners and use the partners manufacturing capabilities. As we use
others to manufacture our products, we depend on those parties to comply with cGMPs, and other regulatory requirements and to deliver materials on a timely basis. These parties may not perform adequately. Any failures by these third parties may
delay our development of products or the submission of these products for regulatory approval.



We depend on third-party research organizations to design and conduct our laboratory testing and human studies. If we are unable to obtain any necessary testing services on acceptable terms, we may not complete our
product development efforts in a timely manner. As we rely on third parties for laboratory testing and human studies, we may lose some control over these activities and become too dependent upon these parties. These third parties may not complete
testing activities on schedule or when we request.



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Because neither we nor any of our collaborative partners have received marketing approval for any product resulting
from our research and development efforts, and may never be able to obtain any such approval, we may not be able to generate any product revenue.



All the products being developed by our collaborative partners also will require additional research and development, extensive preclinical studies and
clinical trials and regulatory approval prior to any commercial sales. In some cases, the length of time that it takes for our collaborative partners to achieve various regulatory approval milestones may affect the payments that we are eligible to
receive under our collaboration agreements. We and our collaborative partners may need to address a number of technical challenges successfully in order to complete development of our products. Moreover, these products may not be effective in
treating any disease or may prove to have undesirable or unintended side effects, toxicities or other characteristics that may preclude our obtaining regulatory approval or prevent or limit commercial use.



We may be unable to manufacture or obtain sufficient quantities of our products and ensure
their proper performance and quality.



Biopharmaceuticals
must be produced under the cGMPs of the FDA. We do not have facilities capable of manufacturing drug products under cGMPs and must outsource any such production. We are devoting resources to establishing our own manufacturing capabilities to support
development and preclinical activities and are contracting with third-party vendors for the manufacture of materials for use in humans. We may be unable to contract successfully for cGMPs manufacture of any products and may be unable to obtain
required quantities of our products economically. We may not be able to obtain capacity to produce a sufficient amount of commercial product to meet our commercial and clinical development needs. Failure to meet the demand for product may adversely
affect our ability to continue to market the product.



Compliance with
government regulation is critical to our business and failure to satisfy regulatory requirements could impair our business.



Prior to the marketing of any new drug developed by us, or by our collaborators, that new drug must undergo an extensive regulatory review process in the
United States and other countries. This regulatory process, which includes preclinical and clinical studies, as well as post-marketing surveillance to establish a compounds safety and efficacy, can take many years and require the expenditure
of substantial resources. Data obtained from such studies are susceptible to varying interpretations that could delay, limit or prevent regulatory approval. Even if the FDA approves our products, we will still need to obtain institutional review
board approval, which may involve additional delays. The rate of completion of clinical trials depends upon, among other factors, the enrollment of patients. Patient enrollment is a function of many factors, including:



| |  | timing and restriction of institutional review board approval;
| | - | --------------------------------------------------------------



| |  | the size of the patient population;
| | - | -----------------------------------



| |  | proximity of patients to clinical sites;
| | - | ----------------------------------------



| |  | eligibility criteria for the study;
| | - | -----------------------------------



| |  | time commitment of a patient to the study; and
| | - | ----------------------------------------------



| |  | existence of competitive clinical trials.
| | - | -----------------------------------------



We have not had any of our product candidates receive approval for commercialization in the United States or elsewhere. Neither we nor our collaborators
may be able to conduct clinical testing or obtain the necessary approvals from the FDA or other regulatory authorities for any products. Failure by us or our collaborators to obtain required



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governmental approvals will delay or preclude our collaborators or us from marketing drugs developed with us or limit the
commercial use of such products and could have a material adverse effect on our business, financial condition and results of operations. Even where a product is exempted from FDA clearance or approval, the FDA may impose restrictions as to the types
of customers to which we can market and sell our products. Such restrictions may materially and adversely affect our business, financial condition and results of operations.



In addition, the FDA may condition marketing approval on the conduct of specific post-marketing studies to further evaluate
safety and efficacy. Rigorous and extensive FDA regulation of pharmaceutical products continues after approval, particularly with respect to compliance with cGMPs reporting of adverse effects, advertising, promotion and marketing. Discovery of
previously unknown problems or failure to comply with the applicable regulatory requirements may result in restrictions on the marketing of a product or withdrawal of the product from the market as well as possible civil or criminal sanctions, any
of which could materially adversely affect our business.



We
must obtain regulatory approval by governmental agencies in other countries prior to commercialization of our products in those countries. Foreign regulatory systems may be just as rigorous, costly and uncertain as in the United States.



We rely significantly on our collaborative partners, and our business could be harmed
if we are unable to maintain strategic alliances.



As part
of our business strategy, we have strategic research and development alliances with companies to gain access to specific technologies. These alliances with other pharmaceutical and biotechnology companies may provide us with access to unique
technologies, access to capital, near-term revenues, milestone and/or royalty payments, and potential profit sharing arrangements. In return, we provide access to unique technologies, expertise in genomics, and information on the molecular basis of
disease, drug targets, and drug candidates. To date, we have entered into significant strategic alliances with Abgenix and Bayer, in addition to numerous smaller agreements to facilitate these efforts. In these strategic alliances, either party can
terminate the agreement at any time the alliance permits them to or if either party materially breaches the contract. We may not be able to maintain or expand existing alliances or establish any additional alliances. If any of our existing
collaborators were to breach, terminate or not renew their agreements with us or otherwise fail to conduct activities successfully and in a timely manner, the preclinical or clinical development or commercialization of product candidates or research
programs may be delayed or terminated.



We depend on attracting and
retaining key employees.



We are highly dependent on the
principal members of our management and scientific staff, including Jonathan M. Rothberg, Ph.D., our Chief Executive Officer, President and Chairman of the Board; David M. Wurzer, Executive Vice President, Treasurer and Chief Financial Officer;
Christopher K. McLeod, Executive Vice President; Timothy M. Shannon, M.D., Executive Vice President and Chief Medical Officer; and Richard F. Begley, Ph.D., President and Chief Executive Officer of 454. The loss of services of any of these personnel
could materially adversely affect our business, financial condition and results of operations. We have entered into employment agreements with all of the principal members of our management and scientific staff. We maintain key person life insurance
on the life of Dr. Rothberg in the amount of $2.0 million. Our future success also will depend in part on the continued services of our key scientific and management personnel and our ability to attract, hire and retain additional personnel. There
is intense competition for such qualified personnel and there can be no assurance that we will be able to continue to attract and retain such personnel. Failure to attract and retain key personnel could materially, adversely affect our business,
financial condition and results of operations.



We depend on academic
collaborators, consultants and scientific advisors.



We
have relationships with collaborators and consultants at academic and other institutions who conduct research at our request. These collaborators and consultants are not our employees. Substantially all of our collaborators and consultants are
employed by employers other than us and may have commitments to, or consulting or advisory contracts with, other entities that may limit their availability to us. As a result, we have limited control over their activities and, except as otherwise
required by our collaboration and consulting agreements, can expect only limited amounts of their time to be dedicated to our activities. Our ability to discover genes and biological pathways involved in human disease and commercialize products
based on those discoveries may depend in part on continued collaborations with researchers at academic and other institutions. We may not be able to negotiate additional acceptable collaborations with collaborators or consultants at academic and
other institutions.



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Our academic collaborators, consultants and scientific advisors may have relationships with other
commercial entities, some of which could compete with us. Our academic collaborators, consultants and scientific advisors sign agreements which provide for confidentiality of our proprietary information and of the results of studies. We may not be
able to maintain the confidentiality of our technology and other confidential information in connection with every academic collaboration or advisory arrangement, and any unauthorized dissemination of our confidential information could materially
adversely affect our business, financial condition and results of operations. Further, any such collaborator, consultant or advisor may enter into an employment agreement or consulting arrangement with one of our competitors.



Competition in our field is intense and likely to increase.



We face, and will continue to face, intense competition from one or more of
the following entities:



| |  | biotechnology companies;
| | - | ------------------------



| |  | pharmaceutical companies;
| | - | -------------------------



| |  | academic and research institutions; and
| | - | ---------------------------------------



| |  | government agencies.
| | - | --------------------



We also are subject to significant competition from organizations that are pursuing approaches, technologies and products that are the same as, or similar
to, our technology and products. Many of the organizations competing with us have greater capital resources, research and development staffs and facilities and marketing capabilities. In addition, research in the field of genomics, protein
therapeutics, and fully-human antibodies generally is highly competitive. Our competitors include:



| |  | Human Genome Sciences, Inc.;
| | - | ----------------------------



| |  | Genentech, Inc.;
| | - | ----------------



| |  | ZymoGenetics, Inc.;
| | - | -------------------



| |  | Amgen, Inc.;
| | - | ------------



| |  | Incyte Pharmaceuticals, Inc.;
| | - | -----------------------------



| |  | major biotechnology and pharmaceutical companies; and
| | - | -----------------------------------------------------



| |  | universities and other non-profit research organizations.
| | - | ---------------------------------------------------------



A number of organizations are attempting to rapidly identify and patent genes and gene fragments sequenced at random, typically without specific knowledge
of the function of such genes or gene fragments. If our competitors discover or characterize important genes or gene fragments before we do, it could adversely affect our ability to commercialize our products. We expect that competition in genomics
research, protein therapeutics, and therapeutic antibodies will intensify as technical advances are made and become more widely known. In addition, a number of competitors are producing proteins from genes and claiming both the proteins as potential
therapeutics as well as claiming antibodies against these proteins. In many cases generic antibody claims are being issued by the United



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States Patent and Trademark Office (USPTO) even though competitors have not actually made antibodies against
the protein of interest, or do not have cellular, animal, or human data to support the use of these antibodies as therapeutics. These claims on proteins as therapeutics and these claims covering all antibodies against the proteins and methods of use
in broad human indications are being filed at a rapid rate, and some number of these claims have issued and may continue to issue. In addition, purified proteins, therapeutic data, and antibodies, including polyclonal antibodies, mouse monoclonal
antibodies and, in some cases, fully-human monoclonal antibodies, are being generated against a large number of targets within the human genome. All of these activities may make it difficult to commercialize products, or, if licenses are made
available, may make the royalty burden on these products so high as to prevent commercial success.



We may engage in acquisitions that are unsuccessful.



In the future, we may engage in acquisitions in order to exploit technology or market opportunities. We are not experienced in acquiring and integrating new businesses. If we acquire another company, we may not be
able to integrate the acquired business successfully into our existing business in a timely and non-disruptive manner or at all. Furthermore, an acquisition may not produce the revenues, earnings or business synergies that we anticipate. If we fail
to integrate the acquired business effectively or if key employees of that business leave, the anticipated benefits of the acquisition would be jeopardized. The time, capital management and other resources spent on an acquisition that fails to meet
our expectations could cause our business and financial condition to be materially and adversely affected. In addition, acquisitions can involve material non-recurring charges and amortization of significant amounts of non-cash acquisition costs
that could adversely affect our results of operations.



If our patent
applications do not result in issued patents, then our competitors may obtain rights to commercialize our discoveries.



Our business and competitive position depends on our ability to protect our products, processes and technologies. We continually file patent applications
for our proprietary methods, novel uses of genes, and our development products. As of the date of this report, we had approximately 580 patent applications pending covering novel genes and gene transcripts, as well as our products, processes and
technologies with the USPTO, and had filed numerous corresponding international and foreign patent applications. As of the date of this report, we had been issued approximately 60 patents with respect to aspects of our gene portfolio, products,
processes and technologies.



Our commercial success also
depends in part on obtaining patent protection on genes and proteins for which we or our collaborators discover utility and on products, methods and services based on such discoveries. We have applied for patent protection on novel genes and
proteins, novel mutants of known genes and their uses, partial sequences of novel proteins and their gene sequences and uses, and novel uses for previously identified genes discovered by third parties. We have applied for patents on antibodies
against the proteins we have discovered, as well as seek or have our partners seek patent protection on the antibodies we produce against these proteins. We have sought and intend to continue to seek patent protection for novel uses for genes and
proteins and therapeutic antibodies that may have been patented by third parties. In such cases, we would need a license from the holder of the patent with respect to such gene or protein in order to make, use or sell such gene or protein for such
use. We may not be able to acquire such licenses on commercially reasonable terms, if at all. Our patent application filings that result from the identification of genes associated with the cause or effect of a particular disease generally seek to
protect the genes and the proteins encoded by such genes as well as antibodies raised against these gene products. We also seek patent protection for our therapeutic, diagnostic and drug screening methods and products.



In 2001, the USPTO issued new guidelines for patent applications reflecting
the USPTOs current policy regarding statutory written description and utility requirements for patentability. The implementation of these new guidelines may cause the USPTO initially to reject some of our pending new gene and protein patent
applications. There is no guarantee that the USPTO will approve them. We strive especially to gain issued patents for our commercially important genes and proteins.



The patent positions of pharmaceutical, biopharmaceutical and biotechnology companies, including us, are generally uncertain
and involve complex legal and factual questions. Our patent applications may not protect our products, processes and technologies because of the following reasons:



| |  | there is no guarantee that any of our pending patent applications will result in additional issued patents;
| | - | -----------------------------------------------------------------------------------------------------------



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| |  | we may develop additional proprietary technologies that are not patentable;
| | - | ---------------------------------------------------------------------------



| |  | there is no guarantee that any patents issued to us or our collaborative customers will provide a basis for commercially viable products;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------



| |  | there is no guarantee that any patents issued to us or our collaborative customers will provide us with any competitive advantages;
| | - | -----------------------------------------------------------------------------------------------------------------------------------



| |  | there is no guarantee that any patents issued to us or our collaborative customers will not be challenged or circumvented or invalidated by third parties; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | there is no guarantee that any patents issued to others will not have an adverse effect on our ability to do business.
| | - | ----------------------------------------------------------------------------------------------------------------------



In addition, patent law relating to the scope of claims in the technology
fields in which we operate is still evolving. The degree of future protection for our proprietary rights is uncertain. Furthermore, there can be no assurance that others will not independently develop similar or alternative technologies, duplicate
any of our technologies, or, if patents are issued to us, design around the patented technologies developed by us. In addition, we could incur substantial costs in litigation if we are required to defend ourselves in patent suits brought by third
parties or if we initiate such suits.



The issuance of patents may not
provide us with sufficient protection.



We may not be able
to obtain further patents for our products, processes and technologies, or, if we are able to obtain further patents, these patents may not provide us with substantial protection or be commercially beneficial. The issuance of a patent is not
conclusive as to its validity or enforceability, nor does it provide the patent holder with freedom to operate without infringing the patent rights of others. A patent could be challenged by litigation and, if the outcome of such litigation were
adverse to the patent holder, competitors could be free to use the subject matter covered by the patent, or the patent holder may license the technology to others in settlement of such litigation. The invalidation of key patents owned by or licensed
to us or non-approval of pending patent applications could increase competition, and materially adversely affect our business, financial condition and results of operations. In addition, any application or exploitation of our technology could
infringe patents or proprietary rights of others and any licenses that we might need as a result of such infringement might not be available to us on commercially reasonable terms, if at all. Third parties have indicated to us that they believe we
may be required to obtain a license in order to perform certain processes that we use in the conduct of our business or in order to market potential drugs we have in development.



We cannot predict whether our or our competitors pending patent applications will result in the issuance of valid
patents. Litigation, which could result in substantial cost to us, also may be necessary to enforce our patent and proprietary rights and/or to determine the scope and validity of others proprietary rights. We may participate in interference
proceedings that may in the future be declared by the USPTO to determine priority of invention, which could result in substantial cost to us. The outcome of any such litigation or interference proceeding might not be favorable to us, and we might
not be able to obtain licenses to technology that we require or that, if obtainable, we could license such technology at a reasonable cost.



The public availability of genomic sequence information or other sequence information prior to the time we apply for patent protection on a corresponding
full-length or partial gene could adversely affect our ability to obtain patent protection with respect to such gene or gene sequences. In addition, certain other groups are attempting to rapidly identify and characterize genes through the use of
gene expression analysis and other technologies. To the extent any patents issue to other parties on such partial or full-length genes or uses for such genes, the risk increases that the sale of potential products, including therapeutics, or
processes developed by us or our collaborators may give rise to claims of patent infringement. Others may have filed and in the future are likely to file patent applications covering genes or gene products or antibodies against the gene products
that are similar or identical to our products. Any such patent application may have priority over our patent applications. Any legal action against us or our collaborators claiming damages and seeking to enjoin commercial activities relating to the
affected products and processes could, in addition



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to subjecting us to potential liability for damages, require us or our collaborators to obtain a license in order to
continue to manufacture or market the affected products and processes or could enjoin us from continuing to manufacture or market the affected products and processes. There can be no assurance that we or our collaborators would prevail in any such
action or that any license required under any such patent would be made available on commercially acceptable terms, if at all. We believe that there may be significant litigation in the industry regarding patent and other intellectual property
rights. If we become involved in such litigation, it could consume a substantial portion of our managerial and financial resources.



There is substantial uncertainty concerning the extent to which supportive data will be required for issuance of patents for human therapeutics. If data
additional to that available to us is required, our ability to obtain patent protection could be delayed or otherwise adversely affected. Although the USPTO issued new utility guidelines in July 1995 that address the requirements for demonstrating
utility for biotechnology inventions, particularly for inventions relating to human therapeutics, there can be no assurance that the USPTO examiners will follow such guidelines or that the USPTOs position will not change with respect to what
is required to establish utility for gene sequences and products and methods based on such sequences.



We cannot be certain that our security measures will protect our proprietary technologies.



We also rely upon trade secret protection for some of our confidential and proprietary information that is not subject matter for which patent protection
is being sought. We have developed a database of proprietary gene expression patterns and biological pathways which we update on an ongoing basis and which can be accessed over the Internet. We have taken security measures to protect our proprietary
technologies, processes, information systems and data and continue to explore ways to enhance such security. Such measures, however, may not provide adequate protection for our trade secrets or other proprietary information. While we require
employees, academic collaborators and consultants to enter into confidentiality and/or non-disclosure agreements where appropriate, any of the following could still occur:



| |  | proprietary information could be disclosed;
| | - | -------------------------------------------



| |  | others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets or disclose such technology; or
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | we may not be able to meaningfully protect our trade secrets.
| | - | -------------------------------------------------------------



We depend upon our ability to license technologies.



We may have to acquire or license certain components of our technologies or products from third parties. We may not be able to acquire from third parties
or develop new technologies, either alone or with others. Failure to license or otherwise acquire necessary technologies could materially adversely affect our business, financial condition and results of operations.



The 454 Life Sciences technology platform is in development and the early stages of
commercialization.



The technology platform of 454, our
majority-owned subsidiary, is still in development and 454 has not had significant sales of its services or products. 454 may not be able to continue to successfully develop or commercialize the 454 technology platform. The success of
commercialization of the 454 technology platform depends on many factors, including:



| |  | the acceptance of 454s technology in the market place;
| | - | -------------------------------------------------------



| |  | technical performance of 454s platform in relation to existing technologies;
| | - | -----------------------------------------------------------------------------



| |  | 454s ability to obtain key components for the manufacture of the 454 instrument and reagents from suppliers; and
| | - | -----------------------------------------------------------------------------------------------------------------



| |  | 454s ability to obtain licenses to resell reagents for use in the 454 instrument, if required.
| | - | -----------------------------------------------------------------------------------------------





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454 is subject to competition from organizations that have developed or are developing technologies and products to
service 454s potential customers.



Many of the
organizations competing with 454 potentially have greater capital resources, research and development staffs and facilities and marketing capabilities. 454s potential competitors include:



| |  | Applied Biosystems;
| | - | -------------------



| |  | GE Healthcare (formerly Amersham Biosciences);
| | - | ----------------------------------------------



| |  | Affymetrix;
| | - | -----------



| |  | Perlegen; and
| | - | -------------



| |  | other companies recently formed or soon to be funded to develop whole genome sequencing technologies.
| | - | -----------------------------------------------------------------------------------------------------



We believe that the future success of 454 will depend in large part on our ability to maintain a competitive position in
instruments for the high throughput nucleic acid sequencing field. Before we recover development expenses for our products or technologies, such products or technologies may become obsolete as a result of technological developments by us or others.
Our products could also be made obsolete by new technologies which are less expensive or more effective. We may not be able to make the enhancements to our technology necessary to compete successfully with newly emerging technologies. A market for
the high throughput nucleic acid sequencing field may not be sufficient to generate revenues significant enough for 454 to achieve profitability.



We could be liable for any failure to comply with hazardous product regulations.



Our research and development activities involve the controlled use of hazardous materials and chemicals. We are subject to
federal, state and local laws and regulations governing the use, storage, handling and disposal of such materials and certain waste products. Although we believe that our safety procedures for handling and disposing of such materials comply with the
standards prescribed by federal, state and local laws and regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of such an accident, we could be held liable for any damages
that result and any liability could exceed our resources.



Risks Related
to Our Financial Results



We have a history of operating losses and
expect to incur losses in the future.



We have incurred
losses since inception, principally as a result of research and development and general and administrative expenses in support of our operations. We anticipate incurring additional losses over the next several years as we focus our resources on
prioritizing, selecting and advancing our most promising drug candidates. We may never be profitable or achieve significant revenues. For example, we experienced net losses of $74.5 million in 2003, $90.4 million in 2002 and $42.9 million in 2001,
and as of March 31, 2004 had an accumulated deficit of $307.5 million.



Our
quarterly operating results have fluctuated greatly and may continue to do so.



Our operating results have fluctuated on a quarterly basis. We expect that losses will continue to fluctuate from quarter to quarter and that these fluctuations may be substantial. Our results of operations are
difficult to predict and may fluctuate significantly from period to period, which may cause our stock price to decline and result in losses to investors. Some of the factors that could cause our operating results to fluctuate include:



| |  | changes in the demand for our services;
| | - | ---------------------------------------



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| |  | the nature, pricing and timing of products and services provided to our collaborators;
| | - | --------------------------------------------------------------------------------------



| |  | our ability to compete effectively in our therapeutic discovery and development efforts against competitors that have greater financial or other resources or drug candidates that
are in further stages of development;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | acquisition, licensing and other costs related to the expansion of our operations;
| | - | ----------------------------------------------------------------------------------



| |  | losses and expenses related to our investments;
| | - | -----------------------------------------------



| |  | regulatory developments or changes in public perceptions relating to the use of genetic information and the diagnosis and treatment of disease based on genetic information;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | regulatory actions and changes related to the development of drugs;
| | - | -------------------------------------------------------------------



| |  | changes in intellectual property laws that affect our patent rights;
| | - | --------------------------------------------------------------------



| |  | payments of milestones, license fees or research payments under the terms of our external alliances and collaborations and our ability to monitor and enforce such payments; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the timing of intellectual property licenses that we may enter into.
| | - | --------------------------------------------------------------------



We believe that quarterly comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of future
performance. In addition, fluctuations in quarterly results could affect the market price of our common stock in a manner unrelated to our long-term operating performance.



The market price of our common stock is highly volatile.



The market price of our common stock has fluctuated widely and may continue to do so. For example, during the first quarter
of 2004, the closing sale price of our stock ranged from a high of $9.46 per share to a low of $5.77 per share. Many factors could cause the market price of our common stock to rise and fall. These factors include:



| |  | variations in our quarterly operating results;
| | - | ----------------------------------------------



| |  | announcements of technological innovations, clinical results, or new products by us or our competitors;
| | - | -------------------------------------------------------------------------------------------------------



| |  | introduction of new products or new pricing policies by us or our competitors;
| | - | ------------------------------------------------------------------------------



| |  | acquisitions or strategic alliances by us or others in our industry;
| | - | --------------------------------------------------------------------



| |  | announcement by the government or other agencies regarding the economic health of the United States and the rest of the world;
| | - | ------------------------------------------------------------------------------------------------------------------------------



| |  | the hiring or departure of key personnel;
| | - | -----------------------------------------



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| |  | changes in market valuations of companies within the biotechnology industry; and
| | - | --------------------------------------------------------------------------------



| |  | changes in estimates of our performance or recommendations by financial analysts.
| | - | ---------------------------------------------------------------------------------



We have a large amount of debt and our debt service obligations may prevent us from taking actions that we would otherwise consider to be
in our best interests.



As of March 31, 2004, we had total
consolidated debt of $241.5 million; and for the year ended December 31, 2003, we had a deficiency of earnings available to cover fixed charges of $80.6 million. A variety of uncertainties and contingencies will affect our future performance, many
of which are beyond our control. We may not generate sufficient cash flow in the future to enable us to meet our anticipated fixed charges, including our debt service requirements with respect to our notes due in 2007 and in 2011. At March 31, 2004,
$240.0 million of those notes remained outstanding. The following table shows, as of March 31, 2004, the remaining aggregate amount of our interest payments due in each of the years listed (in millions):



|           |  |                    |     
|---------- |  | ------------------ | ----
|Year       |  | Aggregate Interest
|2004       |  | $                  | 6.1 
|2005       |  |                    | 12.2
|2006       |  |                    | 12.2
|2007       |  |                    | 8.3 
|2008       |  |                    | 4.4 
|Thereafter |  |                    | 11.0



Our substantial
leverage could have significant negative consequences for our future operations, including:



| |  | increasing our vulnerability to general adverse economic and industry conditions;
| | - | ---------------------------------------------------------------------------------



| |  | limiting our ability to obtain additional financing;
| | - | ----------------------------------------------------



| |  | requiring the dedication of a substantial portion of our expected cash flow to service our indebtedness, thereby reducing the amount of our expected cash flow available for other
purposes, including working capital and capital expenditures;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we compete; or
| | - | --------------------------------------------------------------------------------------------------------------------------



| |  | placing us at a possible competitive disadvantage compared to less leveraged competitors and competitors that have better access to capital resources.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------



Our debt investments are impacted by the financial viability of the underlying companies.



We have a diversified portfolio of investments of which
$135.4 million at March 31, 2004 were invested in U.S. Treasuries and debt investments that are sponsored by the U.S. Government. Our corporate fixed-rate debt investments comply with our policy of investing in only investment-grade debt
instruments. The ability for the debt to be repaid upon maturity or to have a viable resale market is dependent, in part, on the financial success of the underlying company. Should the underlying company suffer significant financial difficulty, the
debt instrument could either be downgraded or, in the worst case, our investment could be worthless. This would result in our losing the cash value of the investment and incurring a charge to our statement of operations.



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We may need to raise additional funding, which may not be available on favorable terms, if at all.



We believe that we have sufficient capital to satisfy our capital needs for
at least the next twenty-four months. However, our future funding requirements will depend on many factors and we anticipate that, at some future point, we will need to raise additional capital to fund our business plan and research and development
efforts on a going-forward basis. To the extent that we need to obtain additional funding, the amount of additional capital we would need to raise would depend on many factors, including:



| |  | the number, breadth and progress of our research, product development and clinical programs;
| | - | --------------------------------------------------------------------------------------------



| |  | our ability to establish and maintain additional collaborations;
| | - | ----------------------------------------------------------------



| |  | the progress of our collaborators;
| | - | ----------------------------------



| |  | our costs incurred in enforcing and defending our patent claims and other intellectual property rights; and
| | - | -----------------------------------------------------------------------------------------------------------



| |  | the costs and timing of obtaining regulatory approvals for any of our products.
| | - | -------------------------------------------------------------------------------



We expect that we would raise any additional capital we require through public or private equity offerings, debt financings
or additional collaborations and licensing arrangements. We cannot be certain that in the future these sources of liquidity will be available when needed or that our actual cash requirements will not be greater than anticipated. In appropriate
strategic situations, we may seek financial assistance from other sources, including contributions by others to joint ventures and other collaborative or licensing arrangements for the development and testing of products under development. If we
raise additional capital by issuing equity securities, the issuance of such securities would result in ownership dilution to our shareholders. If we raise additional funds through collaborations and licensing arrangements, we may be required to
relinquish rights to certain of our technologies or product candidates, or to grant licenses on unfavorable terms. The relinquishing of rights or granting of licenses on unfavorable terms could materially adversely affect our business, financial
condition and results of operations. If adequate funds are not available, our business, financial condition and results of operations would be materially adversely affected. However, should we be unable to obtain future financing either through the
methods described above or through other means, we may be unable to meet the critical objective of our long-term business plan, which is to successfully develop and market pharmaceutical products. If we require additional capital at a time when
investment in biotechnology companies such as ours, or in the marketplace in general, is limited due to the then prevailing market or other conditions, we may not be able to raise such funds at the time that we desire or any time thereafter.



Risks Related to Our Convertible Debt and Our Common Stock into which
Our Debt is Convertible



We have significant leverage as a result of
the sales of our debt in 2000 and 2004.



In February 2000,
in connection with the sale of our 6% convertible subordinated debentures due in 2007, we incurred $150.0 million of indebtedness. In February 2004, we repurchased $20.0 million of these debentures, for total consideration of $20.0 million, plus
accrued interest of $0.05 million to the date of repurchase. As a result of the remaining indebtedness of $130.0 million, our interest payment obligations amount to $7.8 million per year.



In February 2004, in connection with the sale of our 4% convertible subordinated notes due in 2011, we incurred an
additional $100.0 million of indebtedness. In addition, in March 2004, the initial purchasers exercised their option to purchase an additional $10.0 million of 4% convertible subordinated notes due in 2011, providing us with additional net proceeds
of approximately $9.7 million. As a result of this indebtedness of $110.0 million, our interest payment obligations amount to $4.4 million per year. The degree to which we are leveraged could adversely affect our ability to obtain further financing
for working capital, acquisitions or other purposes and could make us more vulnerable to industry downturns and competitive pressures. Our ability to meet our debt service obligations will depend upon our future performance, which may be subject to
the financial, business and other factors affecting our operations, many of which are beyond our control.



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These notes, due in 2007 and in 2011, are effectively subordinated to all of our secured indebtedness and
all indebtedness of our subsidiaries. These notes are our general unsecured obligations and are not guaranteed by any of our subsidiaries. Accordingly, these notes are effectively subordinated to all of our current and future secured indebtedness to
the extent of the assets securing the indebtedness. Furthermore, our right to receive any distribution of assets of any subsidiary upon that subsidiarys liquidation, reorganization or otherwise, is subject to the prior claims of creditors of
that subsidiary, except to the extent we also are recognized as a creditor of that subsidiary. As a result, these notes are effectively subordinated to the claims of such creditors.



There are no restrictive covenants in our indentures relating to our ability to incur future indebtedness.



The indentures governing our notes due in 2007 and in 2011 do not contain
any financial or operating covenants or restrictions on the payment of dividends, the incurrence of indebtedness, transactions with affiliates, incurrence of liens or the issuance or repurchase of securities by us or any of our subsidiaries. We may
therefore incur additional debt, including secured indebtedness senior to these notes. As part of our growth strategy, we potentially may use proceeds from the 2004 offering to finance future acquisitions of complementary businesses or technologies,
which may cause us or our subsidiaries to incur significant indebtedness to which these notes would be subordinate.



These notes, due in 2007 and in 2011, are obligations exclusively of CuraGen Corporation. Our subsidiaries are separate and distinct legal entities. Our
subsidiaries have no obligation to pay any amounts due on these notes or to provide us with funds for our payment obligations, whether by dividends, distributions, loans or other payments. In addition, any payment of dividends, distributions, loans
or advances by our subsidiaries to us could be subject to statutory or contractual restrictions. Payments to us by our subsidiaries will also be contingent upon our subsidiaries earnings and business considerations.



Our debt service obligations may adversely affect our cash flow.



A higher level of indebtedness increases the risk that we may default on our
debt obligations. We cannot be certain that we will be able to generate sufficient cash flow to pay the interest on our debt or that future working capital, borrowings or equity financing will be available to pay or refinance such debt. If we are
unable to generate sufficient cash flow to pay the interest on our debt, we may have to delay or curtail our research and development programs.



The level of our indebtedness among other things, could:



| |  | make it difficult for us to make payments on our notes;
| | - | -------------------------------------------------------



| |  | make it difficult for us to obtain any necessary financing in the future for working capital, capital expenditures, debt service requirements or other purposes;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we compete; and
| | - | ------------------------------------------------------------------------------------------------------------------------



| |  | make us more vulnerable in the event of a downturn in our business.
| | - | -------------------------------------------------------------------



Our ability to repurchase notes, if required, with cash upon a change in control or fundamental change may be limited.



In certain circumstances involving a change in control, we may be required
to repurchase some or all of the notes due in 2007. In certain circumstances involving a fundamental change, we may be required to repurchase some or all of the notes due in 2011. We cannot be certain that we will have sufficient financial resources
at such time or would be able to arrange financing to pay the repurchase price of the notes. Our ability to repurchase the notes in such event may be limited by law, by the indenture and by such indebtedness and agreements as may be entered into,
replaced, supplemented or amended from time to time.



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Securities we issue to fund our operations could cause dilution to our shareholders ownership.



The conversion of our notes into shares of common stock will dilute the
ownership interest of our current shareholders. We may decide to raise additional funds through a public or private debt or equity financing to fund our operations. If we raise funds by issuing equity securities, the percentage ownership of current
shareholders, including the ownership that holders of the notes would have upon conversion, will be reduced, and the new equity securities may have rights prior to those of the common stock issuance upon conversion of the notes. We may not obtain
sufficient financing on terms that are favorable to existing shareholders and us.



Item 4. Controls and Procedures



(a) Evaluation of Disclosure Controls and Procedures



As of the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation was performed under the supervision and with the participation of our management, including the Chief Executive Officer (CEO) and Chief
Financial Officer (CFO), of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based on that evaluation, the CEO and CFO have concluded that
our disclosure controls and procedures were adequate and effective to ensure that material information relating to us, including our consolidated subsidiary, was made known to them by others within those entities, particularly during the period in
which this Quarterly Report on Form 10-Q was being prepared.



(b) Changes in Internal Controls



There have
been no changes in our internal controls over financial reporting, identified in connection with the above-mentioned evaluation of such internal controls that occurred during our last fiscal quarter that have materially affected, or are reasonably
likely to materially affect, our internal controls over financial reporting.



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Part II - Other Information



Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities



On February 17, 2004, we sold $100.0 million aggregate principal amount of convertible subordinated notes due in 2011, bearing an interest rate of 4%,
pursuant to the exemption from registration provided by Rule 144A under the Securities Act of 1933, as amended, and received net proceeds from the sale of approximately $97.0 million. In addition, on March 16, 2004, the initial purchaser
exercised its option to purchase an additional $10.0 million of 4% convertible subordinated notes due in 2011, pursuant to the exemption from registration provided by Rule 144A under the Securities Act of 1933, as amended, providing us with
additional net proceeds of approximately $9.7 million. These securities were sold exclusively to qualified institutional buyers and are convertible into our common stock at a conversion price of $9.69 per share, subject to adjustment in certain
circumstances.



Item 6. Exhibits and Reports on Form 8-K



A. Exhibits



|             |  |                                                                                                                                                               
|------------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit 10.1 |  | 1997 Employee, Director and Consultant Stock Plan, as amended and restated through March 24, 2004.                                                            
|             | 
|Exhibit 31.1 |  | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                           
|             | 
|Exhibit 31.2 |  | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                           
|             | 
|Exhibit 32   |  | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code).





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|B. | Reports on Form 8-K
|-- | -------------------



On February 6, 2004 we furnished a report on Form 8-K under Item 12, Results of Operations and Financial Condition, announcing financial
results for the quarter and year ended December 31, 2003 and guidance on our business and financial outlook for the current year.



On February 10, 2004 we furnished a report on Form 8-K under Item 9, Regulation FD Disclosure, announcing our intent to offer, subject to
market and other conditions, $75.0 million aggregate principal amount of convertible subordinated notes due in 2011 in a private placement pursuant to Rule 144A under the Securities Act.



On February 12, 2004 we furnished a report on Form 8-K under Item 9, Regulation FD Disclosure, announcing the
pricing of a private placement of $100.0 million aggregate principal amount of convertible subordinated notes due in 2011, bearing an interest rate of 4%, pursuant to Rule 144A under the Securities Act of 1933, as amended.



On February 26, 2004 we furnished a report on Form 8-K under Item 9,
Regulation FD Disclosure, announcing that the U.S. Food and Drug Administration granted orphan drug designation to CG53135 for the treatment of radiation induced oral mucositis.



On March 17, 2004 we furnished a report on Form 8-K under Item 9,
Regulation FD Disclosure, announcing the sale of an additional $10.0 million aggregate principal amount of convertible subordinated notes due in 2011, bearing an interest rate of 4%, to certain initial purchasers.



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SIGNATURES



Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



|                   |  |                     |  |                                                                                                                               
|------------------ |  | ------------------- |  | ------------------------------------------------------------------------------------------------------------------------------
|Dated: May 6, 2004 |  | CuraGen Corporation
|                   |  |                    
|                   |  | By:                 |  | /s/ Jonathan M. Rothberg, Ph.D.                                                                                               
|                   |  |                     |  | Jonathan M. Rothberg, Ph.D.                                                                                                   
|                   |  |                     |  | Chief Executive Officer, President and                                                                                        
|                   |  |                     |  | Chairman of the Board                                                                                                         
|                   |  |                    
|                   |  | By:                 |  | /s/ David M. Wurzer                                                                                                           
|                   |  |                     |  | David M. Wurzer                                                                                                               
|                   |  |                     |  | Executive Vice-President, Chief Financial Officer and Treasurer (principal financial and accounting officer of the registrant)



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CURAGEN CORPORATION



EXHIBIT
INDEX



|             |  |                                                                                                                                                               
|------------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|No.          |  |                                                                                                                                                               
|Exhibit 10.1 |  | 1997 Employee, Director and Consultant Stock Plan, as amended and restated through March 24, 2004.                                                            
|             | 
|Exhibit 31.1 |  | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                           
|             | 
|Exhibit 31.2 |  | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                           
|             | 
|Exhibit 32   |  | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code).



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